To determine an annual rate of premium to be charged for an auto insurance policy, insurers establish a formula. The formula is typically filed with a state regulator and is changed only occasionally, for example from every 6 months to 2 years. The use of such a formula results in some drivers paying higher-than-average premiums and other drivers paying lower-than-average premiums. The basis for varying the price by driver is the insurers' recognition of risk factors related to the costs of claims. Risk factors are characteristics that inform an insurer about the cost of claims. For example, teenage drivers have more claims per car per year than middle-aged drivers. Therefore, age is used as a risk factor, and teenage drivers are charged higher-than-average rates. Insurers typically use tables to map risk factors to parameters that are used in the rating formula. For example, a typical rating formula has the form:Premium=BR*F1*F2* . . . *FN+E 
In this formula, BR is a base rate level. The base rate is a parameter in an insurance ratemaking formula that is chosen. F1, F2, . . . FN are parameters that are associated with risk factors, and E is a number that can represent a variety of factors for an additional premium. In this equation, F1 may be a factor based on, for example, the age of a driver. An insurer would possess a table that stipulates which value to use for F1 based on the driver's age. One such example is depicted in Table 1 below.
TABLE 1AgeFactor163.0172.5182.0191.8201.721-241.525-291.230-501.0. . .
In some cases, there are formulas that are used to determine one or more of the risk factors. For example, insurers typically surcharge drivers who have had recent accidents or violations. The risk factor for drivers with no past accidents or violations is typically 1.0. For drivers with past accidents or violations, the amount of the surcharge, and therefore the size of the corresponding risk factor, depends on the number, type, and proximity in time to the present of past accidents and violations. For example, a citation for reckless driving may receive a larger risk factor than a citation for exceeding the speed limit by 8 m.p.h.
In the insurance industry, most conventional insurance policies currently offered involve the charging of a fixed cost for a given period of time. For example, a customer may purchase a vehicle insurance policy having a six-month policy period, and the customer estimates the number of miles he or she expects to drive the vehicle during that period.
Typically, companies quote costs in part based upon the estimated miles driven. For an average range of miles, companies typically offer no mileage discount or surcharge. For example, some companies provide no discount or surcharge when the estimated annual mileage is between 7,500 to 15,000 miles. Discounts of a certain percentage (for example, in the ten to fifteen percent range) may be applied by some companies to costs when the customer predicts annual mileage that is lower than the average range. The amount by which estimated mileage must be lower than average for a customer to qualify for a discount may vary by company. Additionally, surcharges of ten percent and more may be applied by some companies to vehicles where the customer predicts that he or she will exceed the average range.
The use of such estimated annual mileage in the calculation of a personal auto insurance premium is standard practice within the insurance industry. Currently, insurers typically classify annual mileage into a relatively small number of tiers, usually two or three, and apply the same rating factor to the entire tier. For example, a typical rating plan might classify annual mileage as “<8,000”, “>=8,000 and <25,000” or “>=25,000”, and a vehicle that is driven 800 miles annually would receive the same rating factor as a vehicle that is driven 7,999 miles annually. This approach is depicted in FIG. 7.
The standard approach to using annual mileage recognizes a perception that, as a group, people who drive less than the average driver have less-than-average annual costs of claims. Using annual mileage in a rating plan makes the premium charged to each individual driver reflect what has been believed to be the average claim cost differences between high and low mileage classes.
An issue with this standard approach, however, is that it is possible to further refine annual mileage classes if accurate measurements of annual mileage are available. Furthermore, the cost of claims for each annual mileage amount can be estimated using a continuous curve which relates annual mileage of any amount to cost per mile driven. Furthermore, the standard approach discussed above assumes a relationship between the expected cost and different mileage amounts, which is used to find a rating factor for annual mileage classes which have never been observed using interpolation or extrapolation from past experience.
An alternative to a fixed cost system involves the use of variable costs. Policies that include variable costs typically charge a customer on a “per mile” basis. The cost is based on a set cost for each mile or kilometer (or other distance unit) driven in a period and assumes that all incremental distances driven (miles, kilometers, etc.) have the same risk associated with them. Under this system, it is assumed that the more a person drives, the more risk the driver assumes; and the chance of having an accident is directly proportional to the number of miles or kilometers driven. The graph of prior art FIG. 1, from the Victoria Transport Policy Institute (March 2003), illustrates this perception that all miles or kilometers driven carry the same amount of risk, i.e., that the first mile driven by a user carries the same amount of risk as any later mile driven. Thus, the prior art treats miles driven and risk as having a substantially linear relationship. Table 2 below shows how a per-mile cost is calculated.
TABLE 2Exposure Unit AnnualMileageRate per MileRate per Exposure Unit1,000$0.05 $502,000$0.05$100
“Exposure” refers to the possibility of a loss and is the basic rating unit underlying an insurance premium. The unit of exposure varies based upon the characteristics of the insurance coverage involved. For automobile insurance, one automobile insured for a period of twelve months is expressed as one car year. Earned exposure units refer to the exposure units that are actually exposed to loss during the period in question. For automobile insurance, one earned exposure is expressed as one Earned Car Year.
An example of a conventional refinement involves the use of a function of the form: y=a*x+b, where y is an annual mileage factor, x is the annual mileage, and a and b are other parameters. This function implies that each additional mile a vehicle is driven adds the same amount of expected cost of claims. The expected cost of claims refers to the anticipated value of the cost of claims, based upon a historical perspective. In other words, this usage-based approach assumes that the overall risk is proportional to the number of miles driven. However, such an assumption is not necessarily correct and may lead to a cost of insurance that does not correspond to a commensurate level of risk. For example, this approach does not take into account factors that cause risk to vary with usage, such as the fact that driving is an acquired skill, and that many drivers become better with practice, thus reducing the risk associated with later-driven miles. An improved approach would reward drivers with more experience and skill by charging less per unit of usage.